EUROPE - Pension funds looking to further hedge against decreasing euro-zone interest rates should consider the options of safe government bonds outside the economic union, consultancy Mercer has suggested.

Dennis van Ek, principal at Mercer suggested exposure to government bonds from commodity-rich countries, citing Norway and Canada with its oil resources, and Australia.

The advice follows recent recommendations by Kames Capital that UK funds consider Australian government bonds as an effective inflation hedge.

"As the universe for AAA government bonds in the euro-zone is shrinking, bonds of politically stable and commodity-rich countries, such as Norway, Canada and Australia, offer excellent opportunities," Van Ek told IPE.

"The same goes for bonds of solid economies, such as Switzerland and Singapore, which can be considered as the ultimate safe havens within the worldwide universe of government bonds."

According to the investment advisor, the average currency return of these five safe havens stood at 25% since the start of the euro-zone crisis.

In Van Ek's opinion, the supply of government bonds of these five countries is considerable and amounted to €100bn for each country.

"Recently we have advised a number of pension funds on the purchase of such bonds for a significant part of their portfolio," he said.

He added that some of the approximately 60 funds advised by Mercer have fully hedged the risks on interest rates on their liabilities through AAA government bonds.

"The coverage ratio of these schemes has only dropped a couple of percentage points during the past months, rather than the much larger decrease at pension funds with an incomplete cover through long-term government bonds," the Dutch consultant said of the local schemes.

"The return on 30-year Dutch and German government bonds has been 15% during the past year. This is what was necessary to keeping up with the increase of liabilities," he added.

That said, the investment advisor stressed that any investment choice has to be made by a pension fund itself, based on the information provided by experts.

"We will never recommend to fully deploy one asset class," he explained. "But if a pension fund wants to fortify its government bonds portfolio for creditworthiness and the protection of purchasing power, we think it is sensible to invest at least a part of the assets in safe government bonds and strong currency outside the euro-zone."

Van Ek emphasised that pension funds with a significant stake in government bonds also need to have an exit strategy, such as a step-by-step consolidation, in case of a further decrease in interest rates.

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